Fed cuts rate to 2%

The Federal Reserve building.(AFP)

By

AFP

PublishedWednesday, April 30, 2008

The Federal Reserve cut its key lending rate by a quarter point Wednesday in a fresh bid to fire up a lagging economy, while giving no clear signal on its next move in view of weak activity and rising inflation.

The cut, the latest in a string of aggressive monetary actions, put the federal funds rate at 2.0 per cent, down sharply from 5.25 per cent last September.

The move had been widely expected, but its statement drew various interpretations.

Peter Kretzmer, economist at Bank of America, said the Fed provided "a more even-handed policy statement that provides room for the central bank to pause and allow easing to date to impact the economy."

Others were less certain.

"Understanding this statement is a lot like reading the Bible and trying to understand it. You can't without some context," said Robert Brusca at FAO Economics. "The verbiage remains cloudy but that the Fed stands ready is clear."

The Federal Open Market Committee said in its statement that financial markets remain under stress and that there is considerable uncertainty about the inflation outlook.

"Household and business spending has been subdued and labour markets have softened further. Financial markets remain under considerable stress, and tight credit conditions and the deepening housing contraction are likely to weigh on economic growth over the next few quarters."

The vote was 8-2 with two dissenting members calling for no change in rates. The central bank said it also decided to lower its discount rate for direct bank loans by a quarter point to 2.25 per cent.

"The Fed still left itself plenty of wriggle room to do what it pleases," said Joel Naroff of Naroff Economic Advisors.

"My view of the statement is that the Fed eased back on its stated concerns about the economy and slightly elevated its worries about inflation."

That view was echoed by Eugenio Aleman, economist at Wells Fargo: "They strengthened their concern about inflation, which I thought was very wise. Everyone knows inflation expectations are going higher, and that is in my opinion the biggest risk going forward."

Aleman said the next move for the Fed is not clear from the latest statement.

"They say the economy is weak, but not weakening, so it might indicate they are done for a while" with rate cuts.

Many analysts had been expecting the Fed to signal a pause in its rate-cutting cycle. Economist Stephen Gallagher at Societe Generale said the latest statement is "a soft, non-binding pause."

"This FOMC statement provides a soft-pause or mixed-risk view that should not be interpreted as an end to rate cuts," he said.

"Further employment weakness and the potential for another outbreak of financial market turmoil remain factors that combined could easily generate additional rate cuts."

The Fed statement cited concerns both on the growth and inflation fronts.

"Uncertainty about the inflation outlook remains high," the FOMC said.

"It will be necessary to continue to monitor inflation developments carefully ... The Committee will continue to monitor economic and financial developments and will act as needed to promote sustainable economic growth and price stability."

Some analysts said the Fed appears to have achieved a modest victory in easing a global credit squeeze and possibly averting a severe downturn in the world's biggest economy after slashing rates by 3.25 percentage points since September.

But debate is still raging on the outlook. The latest data shows an economy that is struggling but still growing.

The Commerce Department reported Wednesday gross domestic product expanded at a 0.6 per cent annual pace in the first quarter, slightly better than expected.

"The numbers are still not showing a recession in a technical sense," Aleman said.

"The problem is that because the economy has grown so little, it feels like a recession - 0.6 per cent is not enough to make up for growth in the US population." (AFP)